Educational Articles

Stock Screen: Bargain Basement Stocks - April 26, 2013

Nira Maharaj
| April 26, 2013

The investing world is often broken down into two broad camps: growth and value. The growth group looks for companies with earnings that are advancing at a material clip. The value camp, meanwhile, looks for stocks that are trading on the cheap. The desire to find undervalued stocks is both emotionally and intellectually appealing—after all, who doesn’t like to take advantage of a sale? Moreover, value investing follows one of the oldest, and most obvious, sayings on Wall Street, “buy low, sell high.”

The problem is that everyone is trying to buy low and sell high, even the growth investors. So it’s important to properly define “cheap” and have a systematic way of identifying candidates that meet that criterion. Equally paramount is remembering that some merchandise winds up on the sale heap because it is damaged in some way. A fact that is as true for stocks as it is for consumer goods.

To help investors cull through the list of potential investments, Value Line provides weekly screens. One of the more useful screens for value investors is the Bargain Basement Stocks screen. The screen is fairly simple, highlighting companies with price-to-earnings multiples and price to “net” working capital ratios near the bottom of the Value Line universe. The idea is to identify companies that are trading cheaply relative to earnings and to the money that would be “left over” if the company were to be liquidated. Note, that most stocks never trade below their liquidation value, but even trading at two or three times that value is noteworthy.

This screen is available every week in the Index section of The Value Line Investment Survey. Subscribers can access the most recent Index here to see all 35 names on the list. Some recent names that may interest value investors are Foot Locker (FL) and LeapFrog Enterprises (LF).

Foot Locker

Foot Locker is a global retailer of athletic footwear and clothing. The company operates under two operating segments: Athletic Stores and Direct-to-Customers. The Athletic Stores segment is one of the world’s largest global athletic footwear and clothing retailers. Its store names include Foot Locker, Lady Foot Locker, and Kids Foot Locker. This segment accounted for 90% of the company’s sales in 2012. The Direct-to-Consumer unit includes Footlocker.com, its e-commerce business, as well as its catalog offerings. This division contributed 10% to Foot Locker’s top line last year. As of 2012, the company operated 3,335 stores worldwide.

Foot Locker realized double-digit sales and earnings growth in 2012, compared to the year prior. Despite ongoing weak demand, (which has plagued the industry and is not specific to Foot Locker alone), we are projecting healthy earnings growth in 2013 and 2014. The company is making valiant efforts to weather the difficult operating landscape through the closures of underperforming stores. Further, it is also seeking other ways to curb operating expenses.

The athletic retailer has healthy growth catalysts that ought to boost sales and share net. At the forefront, the upcoming Jordan launch should help to heighten demand. This brand has long been an extremely popular brand and we do not expect this to change. Furthermore, rising exposure to high-growth international markets should also work in the company’s favor. Indeed, growing middle-class populations in emerging markets have been benefting from increased purchasing power, which should translate into additional aspirational purchases. We think bargain hunters may find this stock intriguing.

LeapFrog Enterprises

LeapFrog Enterprises designs, develops, and markets technology-based educational products. The company’s portfolio encompasses multimedia learning platform offerings which include the highly popular LeapPad and LeapPad2 learning tablets, created for children. The company’s revenue is derived from two sources: US (73% of 2012 sales) and International (27%). Furthermore, LeapFrog has three product categories: Mobile Learning (80% of total sales), Learning Toys (19%), and Other (1%).

LeapFrog has faced its share of challenges in the recent past. Weak consumer spending conditions at home and abroad caused demand to falter, pressuring the company’s top- and bottom-line growth. Nevertheless, we are of the view that the educational-toy manufacturer has weathered the storm and is once again positioned for healthy growth. New and existing products ought to continue to pique consumer interest. Furthermore, sales and earnings momentum ought to be enhanced by the abundant online content library from well-known collaborators such as Disney (DIS – Free Disney Stock Report) and Sesame Workshop. Although the company’s short-term performance is nothing to write home about, capital appreciation potential during the 2016-2018 time frame is above average and may entice patient investors currently looking for a deal.

The company’s shares are currently trading at a lower-than-market relative P/E ratio. Investors are likely a bit cautious about the difficult operating landscape for the toy manufacturer. Yet, we are optimistic in the company’s short-and long-term earnings prospects. LeapFrog continues to pay close attention to its innovation pipeline through the ongoing creations of high-technology educational toys. Such strides ought to enable the company to capture greater market share at home and abroad.

At the time of this article's writing, the author did not have positions in any of the companies mentioned.